Floyd Norris posted a fabulous take down of the report from Goldman Sachs entitled “The Quant Liquidity Crunch."
The annotations are by a hedge fund manager who sent me a copy of the report to Norris. The Goldman quotes from the report are in italics, while the fund manager’s commentary is on regular type.
a) “we do not believe that current prices reflect fundamental values” — based on what? The very models that failed you last week?
b) “No one, however, could possibly have forecast the extent of deleveraging or the magnitude of last week’s factor returns.” Bullshit. Buffett and Munger have been warning about the dangers of
excessive leverage combined with crowded trades for quite some time.c) “what the market experienced in recent days has been completely unprecedented”
More baloney. 100-year storms happen every few years in financial
markets. Always have, always will (though every storm’s a little bit
different — maybe that’s what they mean). The only completely
unprecedented thing was the LACK of any 100-year storms for the past
few years.d) “Going forward, we believe that successful quant managers will have to rely more on unique factors.”
Given that you don’t seem to have come up with any, why should anyone
believe that you will now? And given that every quant manager on the
planet is trying to do the same thing, what makes you think that
everyone else won’t come up with the same “more unique factors”?e) “to protect our investors, we will need to make more of an effort to make sure that our proprietary factors remain proprietary”
Yeah, that’s the problem: other quant managers stealing your highly
proprietary factors of buying stocks with momentum or companies trading
at low multiples of cash flow.f) “In the coming weeks, we will continue to analyze this
extraordinary period. We will also re-evaluate and re-prioritize our
research agenda in light of recent events. Stay tuned. As we continue
to study these events, we hope to gain additional insights that will
help us avoid similar problems in the future.” Translation: we
don’t know what happened to us or what we’re going to do about it, but
we really, really, really don’t want to admit that the fundamental
premise of our business is fatally flawed and shut down, so we’ll come
up with something.g) “we remain confident that stocks with better valuations,
higher profitability, better earnings quality, shareholder-friendly
management, strong momentum and improving analyst sentiment will
outperform” I think they just about covered every single investing cliche here…h) “our process should continue to add value under normal market conditions”
Finally, in the last sentence, they perhaps inadvertently reveal the
truth: their success depends on NORMAL MARKET CONDITIONS! In other
words, what they do works 99% of the time, but the other 1% of the time
they blow up — especially since they insist on using a ton of leverage
because their brilliant models tell them that what happened last week
was a 28-standard deviation event. Hint: IT WASN’T!
Fantastic stuff . . .
Source:
The Quants Explain Disaster
Floyd Norris
Notions on High and Low Finance
NYT, August 15, 2007, 6:16 pm
http://norris.blogs.nytimes.com/?p=244
See Also:
The Shareholder Letter You Should, But Won’t, Be Reading Next Spring
Jeffmatthewsisnotmakingthisup
Wednesday, August 08, 2007
http://tinyurl.com/yuu7jf
Dear Investors, We’re…
Hedge Funds Strain To Find Words to Say ‘Sorry’ for Your Losses
GREGORY ZUCKERMAN
WSJ, August 16, 2007; Page C1
http://online.wsj.com/article/SB118720257346298683.html
The Quants Explain Disaster
Joe Nocera (Subscription): Back in 1998, that now infamous quant fund really did melt down, not only liquidating, but shaking the entire global financial system. Long-Term used complex computer models that failed to anticipate some severe once-in-a-lif…
Love the annotations. Next week should be interesting!
Looking forward to the linkfest
Supposedly all the quants were reading, “The Black Swan” this summer. Guess it was over their heads.
“To continue reading the page you requested, you must be a subscriber to TimesSelect.”
Idiots.
All these generalities are very mundane for Quant aficionados, next time you listen to them, just ask for the assumptions of their models:
Everything remaining the same?
Constant supply of money? (10 years of Mr Greenspan’s gratuities may have helped to develop an interest rate sclerosis)
An ever-expanding universe of assets to fund and a constant price for money?
An expanding ocean of debts with no side effects on pricing?
A risk factor which is a constant?
A cranky hedge fund manager reviews a GS report
Barry Ritholtz at The Big Picture reprints the key part of a Floyd Norris blog entry that is apparently behind the NY Times pay firewall. A hedge fund manager sent Mr. Norris a copy of a recent Goldman Sachs report,
Thursday PM the fed repo’ed ABCP.
These are: Asset Backed Commercial Paper.
Therewas not credit crosis: plenty of money to lend at 6.25 or 5.25.
There was no liquidity crisis!
What happened was the 20 prime player in need of cash and not wanting to keep trash in their folios held back commercial paper worth anything and dumped ABCP backed by sub prime notes.
The fed bit…………..
Mistook dumping certainly a violation of NEPA for a crisis.
I think it’s safe to say that the quants believed their own BS. That’s never a good thing.
V.2 will be the “Qual-Quants”.
can you please post the video of cramer taking credit for “nailing it.” This guy is dangerious — he is the 2008 version of Dow 20,000 circa 2000. His prophecy, if you can call it that, was so unsoundly reasoned that it was embarrassing. the attempt to mask a bailout in populist people losing their homes rhetoric reveals his either ignorance, intoxication or disengeniousness? I’d like to hear the explanation of the economics differ between a low credit buyer entering a home with minimal equity and renting over say the first five years? Oh, wait, there is no difference…
But all this discussion is so pointless — of course quants and other professional investors ignore the possibility of trouble.
They are compensated as a percent of *profits* but do not suffer directly from losses. So suppose you manage money or a company and you know that over a decade the $100m you manage can return a net $50m, would you rather have (ignoring compounding etc.):
1) 10 years of $5m returns (total $50m).
2) 7 years of $10m returns, and 3 years of $10m losses (total $40m).
An investor would prefer 1) but a fund manager or a CEO would prefer 2), and by a large margin.
Put another way, Wall Street and executive compensation is proportional to beta, not alpha. Only suckers get alpha.
marketwhisper:
There’s pleanty of material on Cramer and the two seas of thought that surround him; those waters are pretty well divided at this point. But for your enjoyment, here’s a paragraph from a Barons article (8/18) that I just read on the Etrade site….
“Cramer, by all accounts, had a stellar career as a hedge-fund manager. And he is held out by CNBC as the guy who can help viewers make big money. But a comprehensive and careful review of his stock picks by Barron’s finds that his picks haven’t beaten the market. Over the past two years, viewers holding Cramer’s stocks would be up 12% while the Dow rose 22% and the S&P 500 16%, according to a record of 1,300 of the CNBC star’s Buy recommendations compiled by YourMoneyWatch.com, a Website run by a retired stock analyst and loyal Cramer-watcher.”
This just in:
“NEW YORK (Reuters) – Sentinel Management Group Inc., a U.S. futures commission merchant whose decision to freeze client accounts on Tuesday helped roil global financial markets, filed for Chapter 11 bankruptcy protection late on Friday.
The cash management company, which managed about $1.6 billion of assets, said its board decided it was in ‘the best interests of the corporation, its creditors and other interested parties that a voluntary petition be filed … in an effort to restructure the indebtedness of the corporation,’ according to a filing in the bankruptcy court for the Northern District of Illinois.
Sentinel told clients in an August 13 letter: ‘we are concerned that we cannot meet any significant redemption requests without selling securities at deep discounts to their fair value and therefore causing unnecessary losses to our clients.'”
The formula for this is
Fair value – deep discount = bankrupt
where:
fair value = mark-to-model
Deep discout = mark-to-market
where:
fair value = mark-to-model
Deep discout = mark-to-market
Too funny Winston, thx for the laugh.
Our VERSUS musical political parody website’s Parody of the Week addresses the market turmoil in “BEARISH” (to the Terry Kirkman song “Cherish”). “BEARISH” is on VERSUS at http://versusplus.com, and on YouTube at http://youtube.com/watch?v=37pal-PYTUQ.
Buffet and Munger weren’t the only ones warning about excessive leverage. Jim Rogers, Doug Kass and Nouriel Roubini have been talking for 2 years about how this leverage, combined with a real estate and credit bubble and opaque, poor rated and poor quality derivatives was eventually going to blow up.
What amazes me so much about these quant models (and we might as well throw LTCM in there) is that they consistently assume that prices in a market follow a lognormal distribution. In other words, they look like a bell curve.
But statistical research has shown time and again that prices are leptokurtic. In English, prices spend a lot more time around the mean than standard models predict, but they also have fat tails; there are more extreme events than standard models would predict. And most of those extreme events are to the downside.
I’m getting pretty tired of hearing all of these blown up funds talk about “once in a millenium” events causing their meltdowns. Options traders have known for years about how price distribution works, which is why the good ones make a lot of money – particularly on these extreme events.
These guys are so full of shit they’re going to pop – right along with the brilliant models they’ve designed. I actually heard that some of these quants had said that volatility was dead. Didn’t these guys ever hear of reversion to the mean? For a bunch of mathematicians, they aren’t too bright.
Why is it that Wall Street never seems to learn from its own history. I think I remember what happened to Icarus when he flew too close to the Sun.
“where:
fair value = mark-to-model
Deep discout = mark-to-market”
how about
where:
Hurricane Dean in open ocean = mark-to-model
Hurricane Dean at landfall = mark-to-market
d) “Going forward, we believe that successful quant managers will have to rely more on unique factors.”
Such as planetary cycles and their effect on the markets. :-)
Peter said
« What amazes me so much about these quant models (and we might as well throw LTCM in there) is that they consistently assume that prices in a market follow a lognormal distribution. In other words, they look like a bell curve »
It is a fine assumption in a world of normal statistical distribution, but there is a caveat when the markets are made through computer trading and do not comply with lognormal distribution, the culprits create statistical aberration and claim that in a regular world of normal distribution (read in regular markets) the probability of occurrence of a breakdown is infinitesimal.
The inconsistency of their pleas lies in the parallel systems the one they create and the one they refer to as an excuse for their failure.
(At the time, the promoter of LTCM was quoted saying « I make the markets efficient »).
I notice that so far the banks, which promote the funds and the models, are left unscarred , it is only their funds which are armed.
sweet! It’s getting to be such bullshit that these pr depts for the big brokers pump out. Propaganda is nothing new….but it’s still all white lies. They got greedy. They drank Cramers bull kool aid and didnt read the writing on the wall. Glad someone transated it correctly!
nice work!
“I’m getting pretty tired of hearing all of these blown up funds talk about “once in a millenium” events causing their meltdowns. Options traders have known for years about how price distribution works, which is why the good ones make a lot of money – particularly on these extreme events.
These guys are so full of shit they’re going to pop – right along with the brilliant models they’ve designed. I actually heard that some of these quants had said that volatility was dead. Didn’t these guys ever hear of reversion to the mean? For a bunch of mathematicians, they aren’t too bright.”
My expectation is that they are very bright and understand the points above very well — but they also know exactly which side their bread is buttered on.
If they estimated probabilities realistically, their employers would have to use more conservative strategies which reduce the amount of bonus money available on the upside, as I hinted above.
Since fund managers and their quants suffer much less in proportion to the amount of losses than they benefit in proportion to the amount of profits, any statistical analysis that curtails potential profits for the sake of limiting potential losses is just idiotic for them.